American Eagle and Its Peers Enter the CBD Space

American Eagle Outfitters (AEO) partnered with Green Growth Brands (GGBXF) to sell CBD (hemp-derived cannabidiol) infused body care products in about 500 of its stores and online. Under the deal, which was announced on July 11, Green Growth will exclusively develop CBD-infused personal care products like lotions, muscle balms, and aromatherapy for American Eagle. The products are expected to be available in October.

Similar CBD partnerships

The partnership with American Eagle is Green Growth’s third major wholesale agreement since the Farm Bill passed in December last year. Earlier, Green Growth announced collaborations with Abercrombie & Fitch (ANF) and DSW—now known as “Designer Brands” (DBI).

In January, Green Growth announced its agreement with DSWto sell Seventh Sense Botanical Therapy CBD products in 96 stores. The agreement followed a successful pilot. Green Growth Brands offered select Seventh Sense products in ten DSW stores. According to Green Growth, 74.4% of the products offered were sold in the first ten weeks of the test.

Why retailers are eyeing the CBD space

From retailers to beverage makers, many companies are looking to capture growth prospects in the CBD space. A Cowen reportindicated that CBD consumer products generated retail sales of about $600 million–$2 billion in 2018. Cowen’s conservative outlook indicates that CBD products could deliver retail sales of $16 billion by 2025.

For American Eagle, adding CBD-infused products to its stores would enhance merchandise offerings and attract more customer traffic. The growing dominance of online retailers like Amazon (AMZN) impacted traditional brick and mortar retailers. Apparel makers, department stores, and other companies in the retail space are exploring various ways to attract customers’ attention and grow beyond the apparel category.

The fact that Green Growth is developing a special line of CBD-infused personal care products for American Eagle might bring more customers to its stores due to the exclusivity involved.

How has American Eagle fared this year?

American Eagle stock has fallen 13.1% on a YTD (year-to-date) basis as of July 12. Abercrombie & Fitch stock has fallen 9.7% this year. Both of these stocks lag the S&P 500, which has risen 20.2% on a YTD basis as of July 12.

American Eagle announced better-than-expected revenues and earnings for the first quarter, which ended on May 4. However, margin contraction in the first quarter and weak guidance for the second quarter disappointed investors.

American Eagle’s first-quarter revenues grew 7.7% to $886.29 million due to the continued strength in the Aerie’s brand and impressive digital sales. The company’s same-store sales rose 6%. The company’s namesake brand registered same-store sales growth of 4%. Aerie’s delivered same-store sales growth of 14%.

American Eagle’s digital sales had low-double-digit growth in the first quarter and accounted for 30% of the overall revenues compared to 29% in the first quarter of 2018. The company’s first-quarter adjusted EPS rose 4.3% to $0.24. Analysts expected an EPS of $0.21 on revenues of $855.58 million.

American Eagle’s gross margin fell by 30 basis points on a year-over-year basis to 36.7% in the first quarter due to higher markdowns and delivery expenses associated with growing digital sales. The company’s operating margin fell to 5.4% in the first quarter compared to 6.2% in the first quarter of 2018.

Growth expectations

American Eagle expects its second-quarter same-store sales growth to be in the low single digits. The company expects its second-quarter EPS to be $0.30–$0.32 compared to $0.34 in the second quarter of 2018. Analysts expect American Eagle’s revenues to rise 4.1% to $1.0 billion in the second quarter. Analysts expect the company’s adjusted EPS to fall 5.9% to $0.32 due to growth investments.

As of July 12, American Eagle was trading at a lower 12-month forward PE ratio of 10.1x compared to Abercrombie & Fitch’s ratio of 15.7x. Analysts expect American Eagle’s revenues to rise 6.0% to $4.3 billion in fiscal 2019. The company expects its fiscal 2019 adjusted EPS to rise 8.8% to $1.61.

American Eagle’s jeans are popular among young shoppers, especially teens. The company’s Aerie’s brand has been attracting female customers with its focus on body positivity. The brand offers lingerie in various sizes. The first quarter was the 18th consecutive quarter of double-digit sales growth for the Aerie’s brand.

Analysts’ expectations

As of July 12, American Eagle was rated as a “buy” by nine out of 17 analysts. Six analysts rated the stock as a “hold,” while two analysts rated it as a “sell.” Certain analysts lowered their target price for American Eagle stock after the company’s weak second-quarter guidance.

On June 6, RBC lowered its target price for American Eagle stock to $23 from $24. Wedbush cut its target price to $20 from $25. J.P. Morgan also lowered its target price to $20 from $24. Cowen and Company revised its target price to $25 from $29. As of July 12, American Eagle’s 12-month target price was $24, which reflects an upside of 43%.

American Eagle’s focus on innovation and its strategy to offer growth categories like CBD-infused products will likely drive its future growth.